Iceland makes a drama out of its crisis

Iceland’s Truth Report (or “Black” Report) into the October 2008 collapse of its banking sector is exactly the sort of forensic inquiry from which a number of other countries where laissez-faire politicians allowed cavalier banks to pursue reckless growth trajectories could also benefit.

The findings of the Truth Report, put together by its Special Investigation Commission and published last Monday, are also being performed in a Reykjavik theater for five days this week (although the performance has been overshadowed by the eruption of Eyjafjallajökull, whose ash plume has grounded many European flights).

The hope is that the thespians’ dramatic version of the 2,000-page report will prove “cathartic” for Iceland’s 304,000 population, many of whom are badly bruised from the collapses of Glitnir, Kaupthing, and Landsbanki.

The report paints a disturbing picture of an out-of-control, unsustainable banking system, that had been allowed to massively outgrow the state’s capacity to step in as lender of last resort. It seems the Icelandic government rather liked having buccaneering bankers and globe-trotting tycoons on its doorstep. It therefore sat idly by while Icelandic banks grew their assets from 100% of GDP on the banks’ privatization in 2003 to more than 900% by 2007.

The report explains how this was only possible thanks to delusional thinking both from government and the wider Icelandic society. The former prime minister Geir Haarde as well as others in government and regulatory authorities are accused of “negligence” in allowing the situation to occur.

One member of the parliament-appointed commission that authored the report, Mark J. Flannery, a finance professor at the University of Florida, puts this rather well in an appendix (Iceland’s Failed Banks: A Post Mortem [PDF, 509 KB]).

“Newly privatised, each of the three main banks came into ownership of three nouveau-rich families in Iceland. The three business blocs then, in a kind of a testosterone-driven pissing contest, used the savings of generations of hard-working Icelanders to storm the global financial market, including the City of London …

“By vigorously enforcing its deregulation policy, the laissez-faire government created a monster it couldn't control: the Icelandic Viking-capitalist was born. Any voice of caution and classical wisdom was dismissed as old-fashioned …

The report reveals that the three failed institutions, Glitnir, Kaupthing, and Landsbanki (owner of the Icesave brand) were effectively controlled by five investors who wielded undue influence, and some of whom acted as shadow directors. Some of these owners pressurized management into providing loans to their companies and those of friendly clients, with little or no collateral.

The report states that the owners of all three of banks “had an abnormally easy access to loans in these banks, apparently in their capacity as owners.” It also found that money was withdrawn by some of these “insiders” only days before the banks went bust. The commission's chair, Pall Hreinsson, said a parliamentary committee will now decide whether legal action should be brought against those named in the report.

Superficially, Iceland’s banks looked quite healthy right even until about March 2008. As they spread their wings internationally, they were all reporting rapid growth, high profits, and abundant capitalization. The warning signs, which included “surprisingly low reported loan problems and a growing (but uncertain) reliance on shares to collateralize their loans” were largely missed, especially by retail depositors in the UK and Holland.

But Flannery said the banks were peculiarly vulnerable to the freezing up of wholesale markets following the Lehman Brothers’ collapse because of investor skepticism about whether they might be misrepresenting their exposure to bad debts. He writes:

“Probably their most serious omission was their inability to convince outside investors that they were following conservative loan underwriting standards … One is left with the strong suspicion that some or all of the banks were insolvent [by October 2008]—and hence that the market’s unwillingness to lend was rational.”

What I’d like to see is a similarly bright light to be shone into the dark corners of the US, British, and perhaps other banking systems. Many remain opaque and poorly understood by the politicians and taxpayers who have stumped up so much to bail them out since October 2008. If there is one lesson from the Icelandic drama, this is it.